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Many successful investors have proclaimed the wisdom of betting
on the jockey rather than the horse when making their investment
decisions. This is entirely sensible, as outstanding
management has certainly proven its value time and again for
start-ups, multi-nationals, private equity firms and hedge
funds. But (to strain this metaphor somewhat) occasionally
the jockey opts for a different race, track, etc. For
private equity firms and hedge funds this is style drift; and it
represents the point at which betting on the jockey gets
complicated. The case of Phil
Falcone, founder and Chief Investment Officer of Harbinger Capital Partners and LightSquared, his
bet-the-firm investment, illustrates the ragged edge of the
conundrum that “bet on the jockey” types can face when the jockey
wakes up one day and decides to use the same horse to play a
different game.

Falcone’s biography illustrates that while it may be
better to be lucky than good, being lucky, good and possessed of
a dogged determination may be the ideal formulation. After
a stint in a professional hockey league in Sweden following his
graduation from Harvard, Falcone became a junk bond trader and
began to build the skills to filter out the noise of the markets
and assess the true value of an asset, regardless of its current
lack of favor. In 1990, the 27 year old Falcone, in
partnership with a former classmate, acquired a small
manufacturer of combs and brushes. The struggling company
eventually went bankrupt and Falcone lost his investment, but the
episode highlighted Falcone’s entrepreneurial, risk-taking
nature. Back on Wall Street by 1995, Falcone continued in
distressed debt and shortly began seeking investors with an
interest in backing him in his own firm. In 2001 investment
firm Harbert Capital Management, having been seeking investment
opportunities in the distressed asset class, seeded Falcone with
$25 million and the firm that would become Harbinger
Capital Partners was born.

For many years, betting on Phil Falcone was the smart move.
A list of some of his investment wins is impressive:

$11 billion in gains in 2007, largely due to a bet on
subprime mortgage bonds

A $25 million in the convertible debt of Fortescue Metals
Group grew to a stake valued at $3.7 billion in late 2008

500% returns (2001 – late 2008) for the main fund of
Harbinger Capital partners, significantly outpacing his asset
class and standard benchmarks such as the S&P 500

This run understandably attracted LPs, and assets under
management peaked at $26 billion.

It was at the apex of his success Falcone decided to build a business, instead of going for the
quick trade. Through a series of debt and equity
investments in satellite companies Inmarsat and SkyTerra Falcone
assembled, for approximately $2 billion, a 56 megahertz block of
radio spectrum. LightSquared is the company Falcone has
created to build a cellular network from this valuable spectrum.
This is basically an attempt to repeat Craig McCaw’s
success with Nextel, whose network was assembled cheaply by
buying up taxi dispatch licenses (any good
restructuring/distressed professional is a font of wisdom on
business plans and it is surely no accident that LightSquared
represents an attempt to replicate such a successful strategy).

Unfortunately for Falcone, the block of spectrum LightSquared
owns is adjacent to the frequency used for GPS signals, and he
has stepped into a hornet’s nest of regulatory intrigue.
Given that his opponents include Senator Charles Grassley
of Iowa, John Deere (yes,
the tractor company), the Pentagon, Verizon
and AT&T (whose lobbying prowess, despite the T-Mobile
debacle, has long been considered formidable), Falcone might
reasonably consider that he is on to something.

Sometimes a powerful investment thesis takes time to come to
fruition. Despite the howls of protest of some LPs, Falcone
has assembled a valuable (possibly worth as much as $17 billion)
block of spectrum, and despite the number and strength of his
current opposition, there seems to be a strong case to be made
that, given his cost basis, LightSquared could in the end be a
highly profitable investment. Style drift may be a sin to
LPs, but the final scorecard for investors like Falcone should
only consider returns. On that score, the jury is still out
on Phil’s latest big bet.

About the author:

David
Johnson is a partner with ACM Partners, a
boutique financial advisory firm providing due diligence,
performance improvement, restructuring and turnaround services to
companies and municipalities. He can be reached at 312-505-7238
or at david@acm-partners.com.